The body's chief executive, Liu Mingkang, used an Asian Development Bank meeting in South Korea to urge banks to "get tough" to enhance a credit culture.
International credit rating agency Standard & Poor's says that non-performing loans could amount to more than 40% of the overall loan book.
However, despite bad debts of more than $200 billion, few in China are keen to sue the worst offenders.
Many of them are state firms and senior individuals in influential families.
And China's legal system has a poor record when it comes to dealing with debtors. But there is a need for action to be taken soon, warn experts.
Effect on growth
Bad loans could seriously check any government attempt to shift some of the imbalances in China's breakneck expansion.
2003 saw the economy grow at 9.1%, with investment in fixed assets up 47% in the first three months of 2004 compared to the previous year.
According to Stanley Fischer - former International Monetary Fund number two and now vice-chairman of Citigroup - that spells serious trouble for the banking system.
"It is inconceivable that those rates of investment can be efficient," he told investors at the ADB meeting.
The distended state of the banking system is one result and needs to be fixed before 2007, when China's commitments to the World Trade Organisation mean it has to open up much of the banking sector to foreign competition.